Torys' Top Ten M&A Trends for 2008

Sharon Geraghty, Richard Willoughby and Philip Brown of Torys LLP

January 9, 2008

During the first half of 2007,
merger and acquisition activity continued
at record levels, fuelled by the availability offinancing
on favourable
terms. However, the "credit crunch" that began in
the summer of 2007 ended what
had been an unusual string of private equity-led and highly
levered mega-deals.
The continuing turmoil in the credit markets will be a key factor
affecting
M&A in 2008.

Torys' M&A
lawyers are looking ahead to 2008, and here's what they
see.

1.
Financing Terms Will Become More Restrictive

The
first half of 2007 saw credit markets that were highly favourable to
borrowers.
A frothy M&A market, coupled with extensive liquidity, made for
intense
competition among lenders. Credit from all sources - banks,
commercial lenders,
pension funds and others - was available in ever-increasing
amounts, at
aggressive leverage levels and historically low credit spreads, and on
covenant
terms that reflected the negotiating leverage of borrowers. Terms such
as
"covenant light" entered the lexicon as many of the
safeguards that lenders
typically look to, including financial covenants, were relaxed or
jettisoned
completely.

The
period had the feel of a party that was soon to end, and it did
- with the
credit crunch that struck over the summer of 2007, precipitated by
developments
in the U.S.
subprime market. In very short order, credit spreads were adjusted,
commitments
once again had substantial conditions attached and leverage tolerance
was reduced
dramatically.

We expect
that the cautious approach by lenders, together with more restrictive
credit
terms, will continue through 2008. The full effect of the subprime
crisis has
yet to be felt in the North American banking industry and, given the
market
uncertainty, it will take some time for lenders' risk
tolerance to begin to
regain some of the ground lost in the latter part of 2007. In
particular, these
are the patterns we expect to see:

Credit spreads
will continue to settle in at higher levels, reflecting the new risk
assessment.

Overall leverage
will decrease, and financial investors will be required to make
significant
equity contributions to transactions - in some recent
transactions this has
been as high as 50%. Both these factors will have a significant impact
on LBO deal
size.

The most
aggressive financing techniques seen in the period leading up to the
summer of
2007, such as lenders providing equity bridges, will not reappear in
2008.

Financing
commitments will not be available for many types of riskier deals that
were
readily underwritten a year ago; moreover, the commitments that are
being
issued will be subject to conditions, such as "market
outs," that lenders were
routinely required to forgo in the first half of 2007.

In loan
documents, borrowers can once again expect to be required to meet
maintenance-style financial covenants, such as maximum leverage ratios
and
fixed-charge coverage ratios, as well as negative covenants of the type
that
have traditionally protected lenders, such as negative pledges.

In broad terms, we expect to see
a continued flight to quality where borrowers with solid fundamentals
will
still have a ready market for their debt requirements, but on terms
that better
reflect historical norms.

2.
Deal Protection
for Sellers Will Be a Key Focus

Buyers caught in the
credit market downswing have been carefully examining whether the
companies
they agreed to purchase have suffered a "material adverse
change" in their
business. Typical merger agreements contain a closing condition that no
material adverse change may occur to the target company's
business during the
period between signing the agreement and completion. Though this
condition was
rarely invoked in the past, in the last few months of 2007, there were
a number
of cases in which a buyer took the position that a material adverse
change had occurred
and, accordingly, it was not required to complete the acquisition or
would
complete it only on renegotiated financial terms. This development will
result
in greater emphasis on deal protection for the seller
during 2008 to limit a buyer's ability to walk away.

In particular, we
expect the following to occur:

Sellers will
attempt to further narrow the definitions of "material
adverse effect" and
"material adverse change" to limit the
circumstances under which such an effect
or a change will potentially be triggered.

Sellers will pay
greater attention to the quantum of "reverse break
fees" and the circumstances
in which a buyer can elect to terminate and pay the reverse break fee.
Financial
sponsors tend to acquire companies through the use of special purpose
shell
vehicles, rather than putting their investors' assets
directly on the line. However,
these sponsors have also in the past agreed to guarantee the
obligations of
that vehicle up to a specified amount - the reverse break
fee. We expect that in
2008, target companies will look to (i) obtain full recourse for the
purchase
price to eliminate the possibility that a buyer will choose to pay the
reverse
break fee and walk away; (ii) provide for a specific performance remedy
that would
allow it to force a closing of the transaction; and/or (iii) negotiate
a higher
reverse break fee that better reflects the "option"
value of a deal with only a
limited monetary remedy for a deliberate failure to close.

Sellers will attempt
to address "third-party beneficiary" issues.
Current merger agreements provide
little scope for shareholders of a target company to sue the buyer
directly for
lost-transaction premiums because shareholders themselves are not
parties. This
has been deliberate because the parties generally do not want to create
a
direct right of action for shareholders that would potentially permit
individual shareholders to interfere with the deal. However, it is
unclear what
damages, other than out-of-pocket transaction expenses, the target
company
directly suffers in the case of a failed transaction since share
premiums are
not payable to the target. Third-party beneficiary provisions are
intended to
allow the target to sue the buyer on behalf of the shareholders for any
lost
premiums.

We believe
that North America
is entering a cyclical
upturn in restructurings, which will result in an increased market for
distressed M&A activity. As noted above, in the past economic
cycle,
markets experienced unprecedented growth in the availability of
liquidity. The
credit markets now appear to be reverting to a normalized historical
pattern
with lenders seeking a more conservative risk/reward equation, which
restricts
the availability of refinancing opportunities for a number of companies
that
borrowed during the liquidity upturn.

As
credit markets tighten and the North American economy slows down, it is
likely
that some companies that have either overleveraged themselves or need
to refinance
existing covenant-light facilities will be forced to explore strategic
alternatives, including restructurings and/or distressed sales of
assets. In Canada,
these
factors will be heightened by the increasing pressure on manufacturers
and
exporters as a result of the rapid appreciation of the Canadian dollar
vis- -vis
the U.S. dollar in an economy where the majority of exports still flow
south of
the border.

For
investors, the cyclical downturn in the economy presents a number of
investment
opportunities. Involvement in distressed M&A can range across a
continuum
from early investment in a distressed company to participation in a
later stage
restructuring as part of a formal court process. Involvement may take
the form
of investments in convertible debt in companies that require a balance
sheet
infusion before a formal restructuring; the purchase of assets from a
company
that requires immediate cash; formal court proceedings to support a
solvent
company's reorganization through a plan of arrangement in
Canada or a Chapter
11 plan of reorganization under the United
States Bankruptcy Code;
or investing in an insolvent company through either a plan of
reorganization
under the Companies' Creditors
Arrangement Act (CCAA) or the Code. In addition,
distressed-fund managers
and strategic acquirors will find opportunities to purchase assets
through a
court proceeding such as a CCAA reorganization, a receivership, a
section 363
sale under the Code or from a post-confirmation liquidating trust.

In
a pre-insolvency situation, we expect that there will be an increased
focus on
the use of plans of arrangement under Canadian corporate statutes, or
plans of
reorganization under the Code, for companies with a sound business
platform that
are facing liquidity issues due to tightening credit conditions or
aggressive
borrowing in the past economic cycle. These are companies that do not
require
the type of major operational restructuring that can be accomplished
under the
CCAA, but may require the use of a plan of arrangement to implement a
debt-to-equity
conversion or a sale of assets. Although plans of arrangement have not
been
used frequently in the past few years to implement financial
restructurings, we
believe that they are well-suited for this purpose.

5. Sale
Processes Will Reflect Diminished
Leverage of Sellers

In the first half of
2007, the value and number of Canadian and U.S.
M&A deals reached record
levels, due largely to the activity of private equity funds and the
enormous
amount of credit available on favourable rates and terms. The reduced
availability of leverage has softened M&A deal activity. We
believe that
the continuing caution in the M&A market will result in fewer
buyers and
less competitive sale processes. We expect to see fewer auctions,
increased use
of post-signing market checks and more buyer-friendly terms in
merger/support
agreements.

We expect that target
boards will look more favourably on pre-emptive bids and post-signing
market
checks (as opposed to auctions) to assist in satisfying their fiduciary
obligation to maximize shareholder value. The "bird in the
hand" will become
more attractive. This impact on the sale process will allow both target
companies and potential buyers to avoid the uncertainty and added
expense of an
auction process.

While Canadian
regulators and courts in both the United States and Canada have
recognized that
auctions are generally the most appropriate way for directors to
fulfill their
fiduciary duty to maximize shareholder value, courts will typically
defer to
directors' reasonable business judgment (including their
decisions to solicit
alternatives), provided that directors act free of conflicts and with
due care
in what they honestly believe to be the company's best interests.

When a target company
agrees to a transaction without conducting an auction or a pre-signing
market
check, target boards will be more likely to
require
"go-shop" clauses in merger/support agreements as a
post-signing market check. Although
go-shop clauses have been used less frequently in Canada than in the
United
States, there have been a number of recent examples in Canada,
including South
Coast Partners' acquisition of Oceanex; Spinrite Acquisition
Corp's acquisition
of Spinrite Income Fund; Behringer Harvard REIT's acquisition
of IPC US REIT;
OMERS' acquisition of Golf Town Income Fund; and Algonquin
Power Income Fund's proposed
acquisition of Clean Power Income Fund.

A go-shop clause is
the opposite of the usual "no-shop" clause (which
prevents a target from
actively soliciting buyers). The go-shop provides a target with a
limited
period following the signing of the merger/support agreement to canvass
the
market for other purchasers. Typically, the target board will agree to
pay a
smaller-than-usual break fee if a competing transaction is agreed to
during the
go-shop period. The break fee will usually increase after the go-shop
period
expires. Provided the target board is comfortable that the go-shop
clause would
give it a meaningful opportunity to solicit a better offer, such a
clause can assist
the target's board in satisfying its fiduciary obligation to
maximize
shareholder value where there has been only a limited auction or none
at all. However,
we expect to see more focus on the length of the go-shop period because
arranging financing in these markets will take more time.

We also expect that
bidders will more frequently demand and be able to secure more
buyer-friendly
terms, such as financing conditions and "hard"
lockup agreements. Although
takeover bids in Canada cannot be subject to a financing condition
(unlike tender
offers in the United States), there are no restrictions on financing
conditions
for acquisitions of private companies or those completed by way of
amalgamation
squeeze-out or plan of arrangement. Given the recent tightening of
credit, we
expect that buyers may be more likely to include financing conditions
in
private company acquisitions to reduce their exposure in the event that
financing is not available at closing though they will not likely be
found in
public company acquisitions.

We
expect buyers will place
increased importance on obtaining irrevocable or hard lockup agreements
to
ensure the successful completion of a transaction, especially in
jurisdictions
like Canada
where companies with significant shareholders are common. Hard lockup
agreements (whereby the shareholder agrees to sell to the original
buyer
regardless of any better offer) are currently less common than
"soft" lockup
agreements (whereby the shareholder is released if the target board
exercises
its fiduciary out). This is in part because institutional shareholders
are
cautious about limiting their ability to tender to a better deal in
light of their
fiduciary responsibilities. However, hard lockup agreements are legally
acceptable in Canada
and can make the success of a deal a foregone conclusion where a
significant
shareholder is in a position to block a change-of-control transaction.
Parties
signing a lockup agreement will want to ensure, however, that they do
not
trigger the "joint actor" rule under Ontario
securities law; otherwise, the selling shareholder's shares
cannot be counted
toward the required minority approval of any subsequent squeeze-out
transaction, and the target board may have to conduct a formal
independent
valuation. Recent decisions have clarified that a joint actor
relationship will
generally exist with a locked-up shareholder only if the shareholder is
involved in the planning or negotiation of the transaction or is an
equity
investor.

6. Strategic
Buyers Will Be More
Competitive

In
the previous period of
favourable credit markets, financial sponsors often significantly
leveraged the
target company to outbid strategic offerors that were subject to
different
capital restrictions or that planned to offer their own shares as
partial or
full consideration. In the current market, we expect strategic bidders
to be
more competitive for several reasons. Strategic bidders have different
considerations in making acquisitions, including transaction synergies
and
competitive factors, that make them less likely to re-evaluate a
transaction on
the basis of short-term market developments. Also, strategic bidders
can offer
shares, may have access to their own stream of cash flow and may have
greater
access to credit if they have a strong balance sheet. All these factors
will allow
them to structure offers that are less subject to credit market
deterioration. Finally,
strategic bidders tend to sign acquisition agreements directly, thereby
becoming liable for failure to complete a transaction -
unlike financial
sponsors, which typically have an acquisition vehicle sign the
agreement. Accordingly,
offers from strategic bidders may have less risk associated with them,
making
them relatively more attractive.

More
activity by strategic
buyers, however, heightens the prospect of competition and antitrust
concerns,
given the potential for in-market acquisitions to increase market
concentration
and confer market power; such activity will thus enhance the importance
of
competition and antitrust considerations in the transaction planning
process.

Share-exchange
acquisitions
by Canadian strategic buyers could also become more complicated if the
Toronto
Stock Exchange enacts new shareholder approval rules. The TSX is
currently
considering whether to require shareholder approval in certain
circumstances where
shares are issued to acquire a public company.

7. Canadian
Acquirors Will Have More
Profile

We expect an increased
number of foreign acquisitions by Canadian businesses, and foreign
investments by
Canadian pension and private equity funds. An obvious reason for this
is the
strength of the Canadian dollar. During the third quarter of 2007, for
the
first time in more than 30 years the Canadian dollar reached, and at
times even
exceeded, parity with the U.S. dollar. Although exchange rates at any
particular moment will not alone drive foreign investment, other
factors are
also aligned. Sector-specific circumstances are at play in, for
example,
financial services, where Canadian banks and insurance companies are
generally
strong relative to potential targets in the United States.

Of particular note is
the increased foreign M&A activity that can be expected from
Canadian
pension plans as they continue to expand their interest in alternative,
non-public market investments. Many Canadian pension plans now have
investment
mandates that allow contributions to be invested in "private
equity-type"
investments, which include being participants in buyouts. This
participation by
Canadian pension plans has recently ranged from passive equity
co-investor to
co-sponsor member of a bidding joint-venture syndicate to outright
acquisitions.
Investment mandates are not limited to Canadian investments and often
expressly
contemplate the making of international investments to diversify the
particular
pension fund's portfolio. Canadian pension funds constitute
some of the largest
and fastest growing pools of available investment funds in the world.
With available
investment capital in the billions of dollars and relatively long-term
investment
realization horizons, Canadian pension plans are expected to be even
more
active in M&A in years to come.

8. Foreign
Buyers Will Also Be
More Prominent

Throughout 2007, strategic buyers
from India,
the Gulf States, Russia
and China
have become increasingly prominent in Canadian and international
M&A
transactions. Spurred on by booming domestic economies and largely
unaffected
by the credit issues, buyers (state-owned and otherwise) from these
countries
are likely to be even more prominent in transactions in 2008.

The potential for
transactions led by these buyers is not likely to be limited to
specific
industry sectors, although mining, metals and commodity-related targets
in Canada
and the United States
are likely to
continue to draw interest, as will targets in the information
technology, life
sciences and automotive industries. Last year, buyers from these
countries looked
increasingly to the financial sector and the investment management
industry,
with several announced transactions involving banks and private equity
and
hedge fund managers. This trend too is likely to continue in 2008
through both
outright acquisitions and investments by buyers who are seeking
strategic
alliances as the ultimate goal.

9. Foreign
Investment
Approval Will Be More Significant in Assessing Deal Risk

Governments
in Canada
and the United States
are tightening
controls on foreign investments as they relate to foreign
state-owned
enterprises and national security. We expect issues relating to foreign
investment to continue to occupy the political spotlight in 2008.

In
Canada,
the government is following
through on plans to critically review the application of the Investment
Canada Act to foreign
investment. It placed restrictions on investments by foreign
state-owned enterprises,
and has announced plans to introduce legislative amendments that would
allow
investments to be blocked on national security grounds. The government
has also
struck a Competition Policy Review Panel to engage in a broader review
of the
key elements of Canada's
investment and competition policies to ensure that they are working
effectively.

New guidelines
clarifying the application of the Investment
Canada Act to
takeovers of Canadian businesses by
foreign state-owned enterprises (SOEs) reflect the
government's policy that the
governance and commercial orientation of SOEs should be taken into
account when
considering whether their investments would be of net benefit to
Canada. Despite
some
uncertainties about how they will work in
practice, the guidelines provide timely and important clarification of
the way
in which the government may be expected to enforce the Act in an era of
active
foreign investment by SOEs.

The
national security
amendments are likely to be more controversial. Previous attempts at
legislative change that left key terms such as "national
security" and
"national interest" undefined were criticized for
potentially giving regulators
broad and open-ended powers to review a very wide range of investments
on
national security grounds. Legislators will need to take particular
care to
ensure that any amendments are not unclear or overly restrictive such
that the
benefits of foreign direct investments are lost as foreign companies
decide to
invest elsewhere.

The
work of the Competition
Policy Review Panel is well underway and may lead to an overhaul of the
Investment Canada Act.
Among other things, the Panel will consider
whether changes
to the Investment Canada Act are
advisable to "address the challenges and complexities of the
modern global
economy." The Panel report is expected in June 2008.

In the United States, the
recently enacted Foreign Investment and
National Security Act
of 2007 (FINSA) expanded the scope of foreign investment that
is subject to
review for national considerations by the Committee on Foreign
Investment in
the United
States.
The term "national security" now includes those
issues relating to "homeland
security," including its application to "critical
infrastructure." FINSA also imposes
a higher level of scrutiny on foreign government-controlled
acquirors, and
provides for a more transparent process than in the past.

This increased
emphasis on foreign investment means that foreign buyers
that are SOEs or that acquire critical infrastructure or other assets
that
might affect national security will be more focused on these foreign
investment
approvals when assessing the completion risk and timing of their
transactions.
We also expect to see provisions in merger or acquisition agreements
dealing
more explicitly with these risks than has been the case in the past.

10.
Infrastructure
M&A Will Be a Bright Spot

Countries all
over
the world, including Canada
and the United States,
are experiencing a growing need to replace or expand their
infrastructure -
roads, railways, bridges, ports, airports, power assets, transmission
lines,
pipelines, and communications networks. As this demand grows, the need
for
private sector investment in infrastructure will continue to increase.
Facing
enormous costs, governments are looking to the private sector for help
- and
infrastructure funds are responding.

In the
past two years, we have seen significant growth in the formation of
specialized
infrastructure funds to provide private sector investment in
infrastructure
assets. We expect this trend to continue in 2008 as more investment
banks and
private equity firms are looking to invest in this unique asset class.
Infrastructure
funds will, however, face stiff competition for these assets from
another class
of investor - the pension funds. Infrastructure assets are
particularly
well-suited for long-term investors such as pension funds, which have
corresponding long-term liabilities. The infrastructure asset class
offers
long-term, inflation-indexed returns, which typically provide stability
over
time.

As
infrastructure and pension funds seek to deploy their capital and as
governments become more comfortable with private sector investment in
the
infrastructure asset class, we expect M&A activity in this
sector to increase.
In addition, with more funds being raised for the infrastructure sector
and
competition for infrastructure assets intensifying, infrastructure
funds may
look beyond the traditional definition of infrastructure to assets that
have
infrastructure-like characteristics and returns; we also expect that
infrastructure funds will look worldwide for opportunities, including
in
non-OECD countries. Finally,
we do not believe
that the credit crunch will affect the infrastructure sector as much as
other
industries. Borrowers with high-quality assets, such as infrastructure
businesses, should still have a receptive market for their debt
requirements.

Sharon
Geraghty, sgeraghty@torys.com,
a co-head of
Torys' M&A Practice Group, practices in the
areas of mergers and acquisitions, corporate governance and securities
law. Sharon has led domestic and cross-border acquisitions, takeover
bids and amalgamations in both the public and private markets. She
regularly acts for multinational corporations in a wide range of
industries, including one of Canada's leading financial
institutions
and one of the world's largest global asset managers focused
on
property, power and infrastructure assets. Sharon also regularly
advises companies, directors and shareholders on corporate governance
and securities compliance matters.

Richard Willoughby, rwilloughby@torys.com,
has a corporate and commercial practice that focuses on
mergers and acquisitions and securities transactions. His mergers and
acquisitions experience includes advising on private acquisitions and
divestitures (often in an auction context), leveraged buyout
transactions, tender offers and joint ventures. His securities
transactions experience includes acting for issuers and underwriters in
public offerings and private placements of equity, debt and derivative
securities, with particular experience in venture capital financings.

Philip Brown, pbrown@torys.com,
is a member of the firm's Executive Committee and a co-head of
the firm's M&A Practice Group. He practices corporate and
commercial
law,
with an emphasis on investment banking, public financing, private
placements and mergers and acquisitions. His primary interest is in
mergers and acquisitions and innovative corporate finance transactions.

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